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Monopoly Power and Endogenous Variety in Dynamic Stochastic General Equilibrium: Distortions and Remedies

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  • Marc Melitz
  • Ghironi, Fabio
  • Florin Bilbiie

Abstract

We study the e¢ ciency properties of a dynamic, stochastic, general equilibrium, macroeco- nomic model with monopolistic competition and …rm entry subject to sunk costs, a time-to-build lag, and exogenous risk of …rm destruction. Under inelastic labor supply and linearity of produc- tion in labor, the market economy is e¢ cient if and only if symmetric, homothetic preferences are of the C.E.S. form studied by Dixit and Stiglitz (1977). Otherwise, e¢ ciency is restored by properly designed sales, entry, or asset trade subsidies (or taxes) that induce markup synchro- nization across time and states, and align the consumer surplus and pro…t destruction e¤ects of …rm entry. When labor supply is elastic, heterogeneity in markups across consumption and leisure introduces an additional distortion. E¢ ciency is then restored by subsidizing labor at a rate equal to the markup in the market for goods. Our results highlight the importance of preserving the optimal amount of monopoly pro…ts in economies in which …rm entry is costly. Inducing marginal cost pricing restores e¢ ciency only when the required sales subsidies are …nanced with the optimal split of lump-sum taxation between households and …rms.

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  • Marc Melitz & Ghironi, Fabio & Florin Bilbiie, 2006. "Monopoly Power and Endogenous Variety in Dynamic Stochastic General Equilibrium: Distortions and Remedies," Working Paper 14401, Harvard University OpenScholar.
  • Handle: RePEc:qsh:wpaper:14401
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    References listed on IDEAS

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    Cited by:

    1. Epifani, Paolo & Gancia, Gino, 2011. "Trade, markup heterogeneity and misallocations," Journal of International Economics, Elsevier, vol. 83(1), pages 1-13, January.
    2. Ippei Fujiwara & Naohisa Hirakata, 2009. "Dynamic Aspects of Productivity Spillovers, Terms of Trade, and the “Home Market Effect”," IMF Staff Papers, Palgrave Macmillan, vol. 56(4), pages 958-969, November.
    3. Jaimovich, Nir & Floetotto, Max, 2008. "Firm dynamics, markup variations, and the business cycle," Journal of Monetary Economics, Elsevier, vol. 55(7), pages 1238-1252, October.
    4. Morrow, John & Dhingra, Swati, 2019. "Monopolistic competition and optimum product diversity under firm heterogeneity," LSE Research Online Documents on Economics 59226, London School of Economics and Political Science, LSE Library.
    5. Kazuyoshi Ohki, 2016. "Welfare analysis and policy implications in Melitz-type model where markup differs across industries," ISER Discussion Paper 0984, Institute of Social and Economic Research, Osaka University.
    6. Swati Dhingra & John Morrow, 2012. "The Impact of Integration on Productivity and Welfare Distortions Under Monopolistic Competition," FIW Working Paper series 088, FIW.
    7. Argia M. Sbordone, 2007. "Globalization and Inflation Dynamics: The Impact of Increased Competition," NBER Chapters, in: International Dimensions of Monetary Policy, pages 547-579, National Bureau of Economic Research, Inc.
    8. Demidova, Svetlana & Rodríguez-Clare, Andrés, 2009. "Trade policy under firm-level heterogeneity in a small economy," Journal of International Economics, Elsevier, vol. 78(1), pages 100-112, June.
    9. Paul Scanlon, 2008. "New Goods and Asset Prices," 2008 Meeting Papers 927, Society for Economic Dynamics.

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